Educational Articles

Coverage Initiation: Domtar Corporation

Robert Harrington
| March 25, 2013

Value Line recently initiated coverage of Domtar Corporation (UFS) in its flagship product, The Value Line Investment Survey. Headquartered in Montreal, the company designs, manufactures, and markets a variety of fiber-based products through three operating segments: Pulp and Paper, Distribution, and Personal Care. Domtar employs nearly 10,000 people and produces the most uncoated freesheet paper in North America and second most in the world.

Previously known as Dominion Tar & Chemical Company, Domtar can trace its roots, in some form or another, back to the early 1840s. After the March 2007 merger with Weyerhauser’s (WY) fine paper business, the current incarnation of Domtar was formed and offered publicly. Trading on both the New York and Toronto Stock Exchanges, the company has experienced a significant material recovery since the recession several years ago.

With 13 mills across the continent, Pulp and Paper is, in many ways, Domtar’s flagship segment, contributing over 80% of companywide sales in 2012. Trade pulp production is split equally between its Canadian and American plants and the company sells 1.6 metric tons of pulp per year depending on market conditions. U.S. operations produce the lion’s share of paper, contributing over 80% of the output in the past year. The manufacturing of wood and paper requires ample resources, chemicals, and energy. The costs associated with energy production, which is most subject to fluctuating rates from local utility companies, are largely taken care of in-house; Domtar’s plants produced 72% of total energy used in 2012. The balance of required energy is provided by local utilities.

The Distribution segment, as its name suggests, executes the purchasing, warehousing, sale and delivery of various products from Domtar (representing roughly 30% of total deliveries) and other suppliers. Under the brand Ariva, the business operates from 18 locations, including 12 distribution centers that are mostly located in the United States. Subsequently, American activity made up over 60% of the segment’s operations in 2012. Over the past few years, Distribution experienced a constant decrease in operating income, an issue that management is focused on turning around through restructuring and improved efficiency.

To the uninitiated, Domtar’s relatively nascent Personal Care segment (founded in late 2011) may appear to be an outlier of sorts with its reliance on the sale of adult incontinence products. But, like its segment contemporaries, the disposable wash cloths and diapers that the group produces under its Attends brand require the same type of pulp-to-product production. The full suite of products offered here should increase in the years ahead. Estimates see people over the age of 65 comprising over 20% of the U.S. population by 2030. It is also believed that one in three members of that age group suffer some degree of incontinence. The segment seems poised to succeed, as it has already posted healthy year-over-year gains in operating income since its inception a year and a half ago. With an aging population, increased awareness for incontinence, and widespread improvements in healthcare coverage, the future is bright for this division.

While Domtar is a long-established player in the industry, it is being confronted with a handful of significant challenges to near- and long-term success. Perhaps the most prominent challenge facing the company is a growing consumer preference for competing technologies and materials. Competitors who employ electronic transmission and document storage tend to carry a wider array of offerings and, as a result, have contributed to the past few years’ sales decreases. The upstart Personal Care group should help ease the pain somewhat. Thus, we are calling for single-digit sales growth in the coming five years. Sale levels are also exposed to several large customer accounts. For instance, 11% of 2012 sales were to office product retailer Staples (SPLS). Should considerable challenges confront any of Domtar’s larger customers, top-line growth could be hurt.

Subscribers interested in this Canadian-based fiber manufacturer and distributor are advised to consult Value Line’s quarterly reports for Domtar, as well as any supplemental reports and relevant articles as important news items arise.

At the time this article was written, the author did not have positions in any of the companies mentioned.